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On The Economy

"One of the most striking features of the present chapter in stock market history is the failure of the trading community to take serious alarm at portents which once threw Wall Street into a state of alarm... Traders, who would formerly have taken the precaution of reducing their commitments just in case a reaction should set in, now feel confident that they can ride out any storm which may develop. But more particularly, the repeated demonstrations which the market has given of its ability to 'come back' with renewed strength after a sharp reaction has engendered a spirit of indifference to all the old-time warnings. As to whether this attitude may not sometime itself become a danger-signal, Wall Street is not agreed."

The New York Times (Sept. 1, 1929)

"The economy is showing secular productivity growth of a magnitude not seen in decades. Inflation remains under control. The U.S. boasts budget surpluses as far as the eye can see. The build-out of the Internet, so rich in promise, is still in its embryonic stages. The stock market excesses of early this year have largely been purged from the system, without exacting any systemic damage. In short, the Goldilocks economy is alive and well and the bull rules."

Barron's (August 28, 2000)

On The Stock Markets

"In many ways this has been the most remarkably cheerful summer in recent financial history. The stock market speaks for itself. After the serious decline in May, prices of the leading securities have been marching steadily upward...This prosperity might be disquieting if it were accompanied by any of the symptoms of inflation."

Outlook & Independent (August 7, 1929)

"For four weeks, stocks have climbed, so much so that this week the Nasdaq composite index - the one so horribly wrecked in March - moved into a plus position for the year...Some see flattening interest rates and an economy essentially under control fueling future market gains."

Seattle Times (August 31, 2000)

Then and Now

As these quotes suggest, some things always seem to remain constant - the sun rising, the seasons changing, or the optimistic outlook toward the stock markets. The bull market in U.S. stocks has been growing now for an unprecedented 10 long years. It can't continue forever. The changing leaves of autumn can also transform Wall Street's bullish tendencies.

Now that the summer doldrums are over and the kids are back in school, the stock market will begin to spin up its volatility. History has shown that October is a very dangerous month for stocks. October has seen some of the biggest stock market crashes and numerous other fender-benders over the decades. October is indeed a frightening month, for trick-or-treaters and stockholders alike. Investors should protect their portfolios through proper diversification. Spreading your assets over a number of stocks and even putting some into bonds will not fully protect your portfolio as effectively as adding a tangible asset like gold.

A Scary Month

The month of October has an eerie effect on the stock markets. October has historically proven to be the most volatile for the U.S. stock market, with a number of individual trading days being particularly explosive during this month. Many investors still remember October 1987 when the Dow dropped from 2641 (Oct. 2, 1987) to 1738 (Oct. 19, 1987) with most of the fall on one very black Monday.

For the Dow Jones Industrial Average, October has been the most hazardous month -- the month of the great stock-market crashes of 1929 and 1987, plus numerous other jolts over the decades, such as the Cuban missile crisis in 1962 and the mini-crash of 1989. Of the 20 largest daily percentage drops in the industrial average, nine have occurred in October, including the three biggest.

The table below highlights the Dow Jones' most dramatic moves during the month of October:

Similar results occurred in the broader stock market index of the S&P 500. Most are surprised to find that October 1987 and October 1929 DO NOT rank amongst the top five worst months in U.S. stock market history. The table below shows the worst percentage returns from the beginning to the end of October, as measured by the Standard & Poor's Composite:

Enhanced Portfolio Diversification

"There's nothing magical about October," said Ken Goldstein, an economist at The Conference Board, a business-financed research group. "People are beginning to take stock of the last year and trying to think of where they go next year from here."

October is simply a time when investors start placing their bets on the coming year. They assess their risk tolerance and redistribute assets in an effort to diversify their portfolios against a stock market downturn. In building an investment portfolio, investors should avoid unnecessary risk through wise diversification.

The key to diversification is finding investments that are not closely correlated with one another. All things being equal, the less the correlation between two investments, the better suited they are for effective diversification.

Many investors combine tangible assets, such as gold, with their stock and bond portfolios to reduce risk. This strategy is based on the fact that gold has historically had a very low, even negative, correlation with stocks and bonds (Figure 1). This means that gold is an excellent asset to hold in conjunction with paper investments in order to reduce total risk. Not only is the risk reduced due to the negative correlation between gold and paper assets, but gold has often produced exceptional investment returns on its own.

Gold's negative correlation with stocks and bonds tends to increase during periods of equity market stress, especially if the drop is unexpected. Here are several reasons:

Gold is a traditional inflation hedge.

Gold tends to perform well when investor confidence is low.

Gold prices tend to move in the same direction as oil prices.

Increases in oil prices are the cause of several stock market declines during the last 32 years.

When redistributing your portfolio's assets, you as an investor should include gold investments in your portfolio for two primary reasons:

The different gold investments provide investors an opportunity to make dramatic positive changes in the value of their investment portfolios.

Gold investments can be very useful in reducing the overall volatility of an investment portfolio because, on average, they tend to move in the opposite direction of paper investments.

The Ultimate Hedge

Gold should form the foundation of your investment portfolio. Because the price of gold is driven by the same supply/demand fundamentals that influence other commodities, and also have historically reacted to inflation, political tensions and economic uncertainty, investments in gold offer opportunities for both capital appreciation and preservation.

The American Eagle gold bullion coin is an excellent way to own and hold gold for your investment foundation. American Eagles are the best-selling gold bullion investment in America. They are traded worldwide on a daily basis as a major component of the international gold market, so they always have a liquid market.

What makes the American Eagle unique is that it is the only gold bullion coin whose weight, content, and purity is backed by the United States Government. You can buy them with confidence knowing each coin contains its stated amount of gold. And since they require no assaying, they can be easily converted to cash at any time without worries or penalties.

The Gold American Eagle

Conclusion

As this month of mayhem passes, investors who take advantage of the safe haven that gold investments provide will not have lost sleep or savings. Those, on the other hand, who did not wisely diversify with gold, might not have enjoyed a month of solace.

October 26, 2000

Blanchard Economic Research
http://www.blanchardonline.com